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Fundamentals can't explain the beating that bonds are taking. It's all about momentum

Fundamentals can't explain the beating that bonds are taking. It's all about momentum
A sign of trouble? The share of auto loans more than 90 days late rose to 4.3% in the first three months of 2018 – the highest in six years. (Alan Diaz / Associated Press)

No one should be surprised by the recent sell-off in the bond market, as it's been anticipated for years. What has been unexpected is the speed of the move.

The yield on the benchmark 10-year Treasury note reached 3.12% on Thursday, the highest since 2011. At the start of this year, economists and strategists didn't foresee yields reaching such levels until mid-2019, Bloomberg News surveys show.

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To value investors, such a move smacks of a market that has overshot to the downside. There are any number of reasons to see bonds as an attractive investment right now — including 10-year yields that are a hefty 1 percentage point above the inflation rate and a global economy that appears to be downshifting.

But like so much else in global markets today, fundamentals hardly matter. It's all about "momentum," and right now betting against bonds is a winning trade.

Commodities Futures Trading Commission data show that hedge funds and other large speculators have built up a record position against 10-year Treasuries, and derivatives suggest that the odds of four interest rate increases by the Federal Reserve this year are getting close to 50%.

"We're not bearish on [Treasuries] as we've seen little to support the notion in the harder data, but we're a bit more sanguine on whether yields can continue to [rise] for the time being," the top-ranked rates strategists at BMO Capital Markets wrote in a research note Thursday.

"The market's doing nothing wrong from a technical perspective and that's an admittedly glib way of saying that momentum is stretched but showing no signs of an imminent reversal."

If the bond market does reverse and begin to rally again, perhaps it will be because of overextended U.S. consumers.

The New York Fed released data Thursday that showed total household debt jumped 0.5% in the first quarter to $13.2 trillion, a new record. At the same time, the number of consumers inquiring about taking on more credit within six months fell 5.65%, the most since the height of the financial crisis at the start of 2009.

The optimists might say that the decline is a good sign because it shows consumers see less of a need to take on debt thanks to the savings realized from tax reform. The pessimists might say it shows a lack of confidence in the outlook for the economy despite any extra savings from tax reform.

It's notable that the New York Fed data also show the share of auto loans more than 90 days late rose to 4.3% in the first three months of 2018 — the highest in six years. In addition, student debt outstanding topped $1.4 trillion for the first time, rising from $1.34 trillion a year earlier.

The economists at housing finance giant Fannie Mae wrote in a research note Thursday that although they see the economy expanding 2.7% in 2018, growth will slow to 2.3% in 2019 as this year's fiscal stimulus fades.

Burgess writes a column for Bloomberg.

bburgess@bloomberg.net

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